Is it time to Strengthen Your Long-term Incentive or Deferred Compensation Plan?

Many companies have or will be taking concerted action regarding their compensation programs in response to the COVID-19 pandemic. As we work to stay on the leading edge of the issues that affect you most, we’ve summarized what has already been observed based on market trends as of this publication¹:

 

• Base Salaries. Approximately 33% of companies either have or will be reducing base salaries in 2020. In addition, nearly 40% of companies have deferred or will be cancelling salary increases for 2020. Salary reductions have generally ranged from 15% for managers and staff, to 20% for executives.
• Bonuses. Nearly 40% of companies will be reducing bonus payouts as compared to prior years; the same number of companies will be adjusting performance goals. A lower percentage of companies have already cancelled bonus payouts for the year, while an increasing number of companies are looking to implement a “plan reset,” that provides for revised goals and adjusted payout terms.
• Long-Term Incentives (“LTI”). Very few companies are doing anything right now with their LTI programs – whether delivered as equity incentives, phantom stock, or other forms of deferred compensation.
• Staffing Actions. Approximately 33% of companies have either implemented furloughs, temporarily impacting approximately 25%-30% of staff, or have completed permanent layoffs, impacting approximately 10% of staff.

 

These trends are logical – the pandemic’s near-term impact on business results has been significant, and conserving cash and reducing expense is critical. Most companies are hoping for a rebound longer-term, and as a result, are “staying the course” on – or in some cases reinvigorating – their LTI plans.

 

A well-crafted or enhanced LTI or deferred compensation plan can be a way to retain and motivate your best people and align them with the company’s goals and objections during a hoped for business recovery.

 

Compensation Plan Alternatives

 

Companies have many compensation plan alternatives from which to choose. The design of these plans is very flexible; they can focus on performance or retention, or both. We are highlighting a few of these alternatives, in order of implementation ease.

 

• Special Retention Program. Setting solid incentive plan goals can be challenging at this time. Accordingly, a special retention program may be the most practical option. A retention program can help a company strengthen retention and motivation of employees deemed important to the company’s future success. These plans are straightforward – they provide a predetermined cash bonus to be paid out at defined dates or events in the future. They can be selective to retain specific key employees or broad-based to maintain operational productivity. The size of the bonus can be tailored by employee or group and payment timing set to a company’s specific needs.
• Deferred Bonus Plan. If a company has historically had an effective annual bonus plan, this alternative can work well. These plans reinforce achievement of near-term results (e.g., quarterly, year-end), typically accompanied by a reset of plan goals. These plans pay a bonus at a date later than when the bonus is earned, based on performance versus plan goals. This approach engages participants to achieve important business goals, while conserving cash and encouraging retention. Depending on the size of the bonuses and levels of participants, all or a portion of the bonus may be deferred. To further enhance retention, the plan can also provide for a bonus “sweetener” also payable at the designated payout date.
• Long-Term Incentive Plan. If reinforcing important longer-term business goals is desired, a phantom-equity plan that mimics equity but pays out in cash, or a performance-based cash plan can provide a very strong longer-term incentive. Phantom-equity plans include stock appreciation rights (SARs) and phantom stock units, while performance-based cash plans are essentially multi-year cash bonus programs. These plans are growing in use and are especially important today as a way to balance the near-term need to conserve cash, while focusing key people on achieving longer-term business goals. The time frame for phantom equity plans is typically open-ended until a participant separates or a liquidity event happens. Performance-based plans typically run for 3-5 years and focus on achievement of very specific profitable growth goals.

 

We note that, to reinforce retention, such plans require that a participant be employed on the payment date. If someone voluntarily leaves the company before the scheduled payment date, he/she would forfeit all or a portion of the payout.

 

Selecting and Implementing a Plan

 

The right alternative will depend on each company’s particular circumstances. Selecting those who should participate is a key consideration; companies need to determine who is critical to its longer term success, who can drive performance longer-term, and where there may be talent at a high risk of loss. There are also a number of administrative issues that need to be addressed and covered by a plan document, spelling out such terms as how and when payouts will occur in order to effectively motivate participants and comply with IRC Sec. 409A. Finally, we emphasize the importance of effective communication and implementation of a new plan.

 

If you have further questions, contact Don Nemerov or your relationship partner at FGMK for more information or to discuss your specific circumstances.

 

¹Information was summarized from two sources: WorldatWork – “How Organizations Are Handling Rewards and Hazard Pay Decisions in a COVID-19 World,” March 2020; Korn Ferry – “Results of 3rd Pulse Survey Impact of COVID-19 on Rewards & Benefits,” May 2020.

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The summary information in this document is being provided for education purposes only. Recipients may not rely  on this summary other than for the purpose intended, and the contents should not be construed as accounting, tax, investment, or legal advice. We encourage any recipients to contact the authors for any inquiries regarding the contents. FGMK (and its related entities and partners) shall not be responsible for any loss incurred by any person that relies on this publication.

 

About FGMK

 

FGMK is a leading professional services firm providing assurance, tax and advisory services to privately held businesses, global public companies, entrepreneurs, high-net-worth individuals and not-for-profit organizations. FGMK is among the largest accounting firms in Chicago and one of the top ranked accounting firms in the United States. For over 50 years, FGMK has recommended strategies that give our clients a competitive edge. Our value proposition is to offer clients a hands-on operating model, with our most senior professionals actively involved in client service delivery.